|
|
|
|
|
So what happens next?
17 January 2010 By Cliff Taylor
Another year older, and still almost as deep in debt. Last year was a year of reckoning in terms of job losses - from the property collapse and from companies in trouble. This year is the year when those with big debts are going to have to start to face up to them. As we saw last week, it will not be pretty.
Developer Bernard McNamara has said he is insolvent, weighed down by a combination of property debts and assets which are worth much less than previously estimated and are not producing income.
Meanwhile, investors who put €170 million equity into the Educational Media and Publishing Group (EMPG) - the company which emerged from the old Riverdeep - are facing a wipeout of their investment as the bondholders who lent to the company move in to take control in a restructuring which will also involve new hedge fund investment.
It is a theme which will repeat itself again and again during the year - business people and companies struggling under the burden of big debts built up during the casino years and hit by an economic downturn, which has left them with nowhere near enough cash flow to meet their repayments.
Debts are fine so long as they are used to buy assets which maintain their value and so long as the borrower is generating enough income to make the repayments. During the boom years it all seemed so easy - buy some property with borrowed money, develop it, sell it on, cash in and move on to the next project. Now, everything has changed.
Barry O’Callaghan’s EMPG is a typical story of the kind of highly leveraged company running into trouble. With debts of $7 billion (€4.8 billion) and annual interest payments of $700 million, a collapse in demand for its products from one of its main customers - the state of California - means it can no longer pay the interest bills. Other highly indebted companies are also struggling to restructure their debt piles.
Independent News & Media has been in the news here, and even the mighty Manchester United FC is trying to re -arrange its borrowings.
As well as businesses - large and small - struggling with debts, there are a thousand other stories we are not hearing, but which could yet create major problems for the banks in terms of bad debts - and have a huge impact on our society.
There are the predominantly young couples in negative equity; at best they are stuck in the house they are in for longer than they intended. At worst, if an earner loses a job, they may be faced with the risk of losing their home. A recent report by ESRI economist David Duffy estimated that some 200,000 households could be in negative equity by the end of this year. International experience would suggest that some 20,000 of these will face problems with repayments.
And there are the smaller scale investors - those who bought a couple of residential properties as investments and may now face difficulty renting them out. In some cases, this will leave them in trouble making repayments. There are more bad debts and more troubles for the banks here.
During the boom years, Ireland borrowed and borrowed.
At the peak of our borrowings in November 2008, the total amount of credit outstanding was a whisker under €400 billion.
For a country whose Gross Domestic Product was €150 billion in 2008, this was a huge debt burden. Our GNP per head in 2008 was just under €35,000; our indebtedness per head was around €93,000. These are crude figures and a range of caveats apply, but you get the picture.
You will have heard a bit of jargon among the financial commetariat, the need for ‘deleveraging’. This means the need to reduce our borrowings. This is required because our new lower level of national income and the collapsed value of the assets on which a lot of the borrowing was taken out demands it.
It is also required because our banks need to reduce the amounts of money they have lent. They need to do this because, in the boom period, they borrowed more and more money abroad to lend on to Irish customers, and that business model is now bust.
Banks are now much, much more cautious about lending to each other after the collapses of the last few years. In future, banks will have to fund borrowings mainly through money they take in from depositors - old style banking.
As banks withdraw credit, bank branches close and thousands of bankers lose their jobs in the months ahead, it will be a case of ‘Honey, who shrunk our financial system?’
So we need to shrink the amount we have borrowed, and our banks need to shrink the amount they have lent. And we have only started. The most recent figures, at the end of last November, showed that the total amount of credit outstanding has fallen, but only by a relatively modest amount - to around €373 billion. What might be a sustainable level? Who knows? But it is likely to be a long way south of where we are.
In many ways the government put these deleveragings ‘on hold’ last year. One of the principal ways to deleverage is to face up to the likely bad debts of big borrowers, restructure, write off a fair amount, and move on. The banks refused to do this as the crisis broke, agreeing to ‘roll over’ interest payments from major developers and basically engage in any manoeuvre which would stop it becoming apparent how much they would have to write off, because writing off bad debts goes straight to the bank bottom line, pushing up losses and eroding capital reserves.
Nama, the national assets management agency, allowed this process to be continued.
The big borrowers remained on life support from the banks because they knew they would get a better deal by dumping the loans onto Nama. The agency will involve write-offs for the banks - as it will pay them less than current value of loans in their books. However, these write-offs will not be anything like as large as if the banks pursued the big borrowers aggressively for repayments.
This would leave them holding only largely unsaleable property of unknown value. At least Nama will give them some cash. This has protected most of the big developers from immediate demands - but not all. Liam Carroll has been pursued through the courts, because a large chunk of his lending came from ACC - a Dutch-owned bank not participating in Nama. The same applied to Paddy Kelly.
Bernard McNamara’s dire financial plight has been highlighted only because clients of Davy stockbrokers, who lent him money for the ill-fated investment in the Irish Glass Bottle site, have come looking for their cash back and have succeeded in the courts. Had this not happened, McNamara would, along with many other big developers, been waiting for Nama.
The loans for the main developers are due to transfer to Nama next month - and what happens in future months will tell a lot Some of the big developers will be able to meet their repayments and will continue as normal. However, many - presumably the majority - will be facing problems. The US experience when it set up similar structures to deal with bank failures shows that, with each developer, Nama will face a choice. Does it work with the developer or pursue him for debts - in many cases presumably leading to personal bankruptcy?
The issue will also be coloured by whatever decisions Nama takes in terms of developing properties. It will need to develop some properties and will need builders and developers to work with Nama to get this done. Presumably, some of the longer established and more solvent operations will get priority, and some of the more indebted developers will be closed down. Only time will tell on this. But one thing is for sure - McNamara will not be the last developer to run into trouble this year.
So Nama will be a big factor in the deleveraging process to come. And so will the realisation of losses of investors in a whole range of areas - those who are particularly exposed are those who borrowed to invest in structures which themselves were based on heavy borrowings.
These would be typical of the kind of syndicated structures set up by stockbrokers and investment advisers for clients in recent years. for everything from EMPG to the Irish Glass Bottle site to buying office blocks in Berlin.
Meanwhile, market analysts are asking what horrors are hidden in the €100 billion extended to residential mortgage borrowers. More bad debts are certain to emerge here. The question is how much and also how quickly they will emerge.
The banks are being encouraged not to foreclose too quickly, but inevitably, with unemployment at levels not seen since the 1980s, this area of debt will be another big focus of 2010.
One of the big questions is where these debts will finally fall. In some cases, investors or developers will take the hit. In many cases, they won’t be able to repay, leading to big writedowns for the banks. In turn, these will deplete the capital base of the banks. In many cases, the taxpayer will be expected to fill this hole.
Where losses from the unwinding of the debt mountain will fall will be a huge area for debate this year. What will be the impact on bank shareholders? Can some of the losses be imposed on bank bondholders? How much can the big debtors pay? And so on.
It is important to realise that there is a continued incentive for the banks to delay and delay.
Delaying - and only recognising bad debts over a prolonged period - allows banks gradually to deal with the problem, using the considerable cash they still earn from their ongoing operations to return slowly to financial balance.
The trouble for the rest of us is that doing this delays facing up to the inevitable and also delays the emergence of banks with strong balance sheets able to engage normally in new lending. The government is trying to address this problem through Nama and through some kind of a recapitalisation programme now under active discussion.
Having be en on hold throughout last year, it looks like the deleveraging process will accelerate through this year. By 2011, we will be another year older and a bit less deep in debt.
Unfortunately, as this unfolds, there will be more financial casualties in many areas of society - from big developers to investors to mortgage holders.
|
|
|
